U.S. Supreme Court Denies Certiorari and Affirms Discovery in Bondholder Litigation against Argentina

U.S. Supreme Court Denies Certiorari and Affirms Discovery in Bondholder Litigation against Argentina

Issue:

23

Volume:

18

By:

Karen Halverson Cross

Date:

October 15, 2014

On June 16, 2014, the U.S. Supreme Court issued several decisions that will significantly change the landscape for enforcement of foreign sovereign debt obligations in U.S. courts. In Republic of Argentina v. NML Capital, Ltd. (NML Capital),[1] the Court held that the U.S. Foreign Sovereign Immunities Act (FSIA) does not limit a court’s power to order post-judgment, worldwide discovery. In a separate decision involving similar parties,[2] the Court denied Argentina’s petition for certiorari to review a Second Circuit decision (NML II)[3] upholding controversial injunction orders. The orders enjoined Argentina to pay NML Capital, Ltd. and the other plaintiffs (collectively NML) whenever it pays the holders of its restructured debt and threatened to sanction participants in the international payment system who aid or abet Argentina in defiance of the orders (Injunction Orders). Finally, the holders of Argentina’s restructured debt submitted a separate petition for certiorari to review the Injunction Orders, which the Supreme Court also denied.[4] These decisions affect the dynamics of sovereign debt restructuring and broaden the permissible scope of enforcement measures affecting foreign state property.

Background

Argentina issued the relevant debt instruments pursuant to a 1994 agreement in which Argentina agreed that its payment obligations under the bonds would “rank at least equally” with its other unsecured and unsubordinated external debt (pari passu covenant), and waived its sovereign immunity.[5] Argentina defaulted on over US$80 billion of its external debt in 2001. It succeeded in restructuring over 90% of the debt by entering into two bond exchanges—in 2005 and 2010—in which Argentina’s creditors agreed to accept new debt instruments worth about one-third of the debt’s original face value. NML, a distressed debt fund,[6] is among the holdout creditors who refused to participate in these restructurings. Instead, it brought suit in New York federal district court and obtained judgments for the full outstanding amount of the defaulted debt.[7] But Argentina has refused to pay, and NML has been largely unable to find non-immune property against which to execute the judgments.

Discovery Order

NML tried for years without success to find Argentine assets against which to execute its judgments. In 2010, NML served document subpoenas on Bank of America and Banco de la Nación Argentina, seeking to locate Argentina’s accounts and learn how it “moves its assets through New York and around the world.” The district judge granted NML’s motion to compel compliance (Discovery Order), stating that the court intended to serve as a “clearinghouse for information” to assist NML in its enforcement efforts.[8]

The Second Circuit affirmed the Discovery Order, finding that the FSIA does not limit the district court’s power to order post-judgment discovery.[9] After the Supreme Court granted Argentina’s petition for certiorari, the U.S. government filed an amicus brief, and the Deputy Solicitor General appeared at oral argument, in support of Argentina’s position.

Argentina and the U.S. argued that the Discovery Order was overly broad and contravened the FSIA. In particular, they invoked the FSIA’s execution provisions, which protect the property of a foreign state against execution, subject only to exceptions for property used for a commercial activity by the foreign state within U.S. territory.[10] Although Argentina had waived its immunity from execution, the U.S. argued that the FSIA’s execution provisions still establish a limit on property that is eligible for execution and therefore limit the property subject to a discovery order.[11]

Justice Scalia delivered the Court’s opinion affirming the Second Circuit. It interpreted the FSIA’s general silence with respect to discovery to mean that the FSIA does not limit a court’s discretion to order discovery of a foreign state’s assets, finding that any “gap” in the FSIA regarding discovery is for Congress to resolve.[12] The Court also found that the FSIA’s text accords execution immunity only to a foreign state’s property that is located in the U.S.[13]

Injunction Orders

The Injunction Orders were issued in connection with different litigation. NML brought suit in New York federal district court to demand specific performance of an additional amount of Argentine debt, alleging that Argentina breached the pari passu covenant in the debt instrument. In February 2012, the district court granted NML’s request for an injunction, directing Argentina to make a “ratable payment” to NML whenever it pays the holders of the restructured debt (NML I). It interpreted the pari passu covenant to require Argentina to extend equal treatment to NML when making payments to holders of the restructured debt.[14]

The U.S. Department of Justice, joined by the Departments of Treasury and State, submitted an amicus brief to the Second Circuit urging reversal, arguing that the district court’s interpretation of the pari passu covenant was inconsistent with “settled market expectations” and, by directing Argentina to use its extraterritorial, immune assets to pay NML, the injunction contravened the FSIA’s execution provisions.[15] It quoted a well-known Second Circuit decision[16] in maintaining that a court cannot grant through an injunction relief that the FSIA prohibits the court from granting by attachment.[17] The Second Circuit disregarded these arguments. It upheld the district court’s interpretation of the pari passu covenant.[18] It also found that the injunction did not attach, arrest, or execute upon any of Argentina’s property, and therefore it did not function as an attachment.[19] The Second Circuit remanded for the district court to clarify the order’s effect on third-party participants in the international payment system.[20]

In November 2012, the district court amended its order to clarify that Federal Rule of Civil Procedure 65(d)(2) prohibits domestic and foreign participants in the payment process for the restructured debt (including the trustee for the restructured bondholders and clearing systems such as Euroclear SA) from aiding and abetting Argentina in defying the order.[21]

In August 2013, the Second Circuit reaffirmed the Injunction Orders but stayed their enforcement pending appeal to the Supreme Court.[22] The court invoked New York’s status as a leading commercial center, stating that this status is “advanced by requiring debtors, including foreign debtors, to pay their debts.”[23]

Argentina filed a petition for certiorari to review the Second Circuit decision. A group of holders of Argentina’s restructured debt filed their own petition, arguing that the Injunction Orders use the restructured debt obligations as leverage to coerce Argentina into paying NML. Given Argentina’s steadfast refusal to pay NML, they argued that the orders increase the risk of Argentina’s default on the restructured debt and therefore constitute a taking of the bondholders’ property.[24] After numerous amici, including several foreign states, filed briefs on both sides, the Supreme Court denied both petitions.

Implications

An immediate consequence of the Supreme Court’s denial of certiorari was that the stay on enforcement of the Injunction Orders was lifted. Barred from making payment on the restructured debt, Argentina is now in default on that debt. It remains to be seen whether Argentina will somehow evade the Injunction Orders in order to pay the restructured debt holders. In September 2014, the district judge found Argentina in contempt of court for its efforts to do so.

Since the 1970s, when waivers of immunity from suit became commonplace in sovereign debt instruments,[25] the principal barrier to enforcing foreign sovereign debt obligations in U.S. courts has not been obtaining a judgment against the sovereign debtor, but finding non-immune assets against which to execute the judgment. By making it difficult for creditors to enforce such judgments, the immunity of foreign sovereign property from execution has facilitated voluntary workouts of sovereign debt crises, effectively substituting for the lack of an international bankruptcy regime for states.[26] The Second Circuit’s decision to uphold the Injunction Orders makes participation in future restructurings less attractive for creditors.[27] By enjoining Argentina from making payments on the restructured debt without paying NML, the Injunction Orders increase the risk of default on the restructured debt, thereby diminishing its value. Thus, the Supreme Court’s decision to let the Injunction Orders stand may complicate the resolution of future sovereign debt crises because creditors will be less likely to agree to restructurings.

The UN General Assembly reacted to the NML litigation by adopting a resolution to establish a multilateral legal framework for sovereign debt restructuring.[28] Although the NML litigation has prompted calls for a revival of the International Monetary Fund’s 2001 proposal to amend its Articles of Agreement so as to create a sovereign debt restructuring mechanism, the prospects for the adoption of such a proposal remain remote.[29] In NML II, the Second Circuit suggested that future sovereign debtors and creditors are free to redraft their contracts, including the pari passu covenant, in order to minimize the prospect of holdout litigation.[30] The International Capital Market Association has already responded. In August 2014, it adopted a proposal to limit the risk of holdout litigation by amending the pari passu covenant and rewriting collective action clauses[31] in standard sovereign debt contracts.[32]

The NML litigation also has implications for foreign states facing enforcement of judgments in U.S. courts outside of the sovereign debt context. By holding that the FSIA does not limit a court’s discretion to order post-judgment discovery, NML Capital changes the law in the Fifth, Seventh, and Ninth Circuits, where courts until now have held that the FSIA limits the scope of post-judgment discovery against a foreign state.[33] Additionally, the Court’s reasoning in NML Capital flatly rejects an argument the U.S. made repeatedly in the NML litigation: that the FSIA’s execution provisions protect against court orders directed at the extraterritorial property of a foreign state.

The U.S. also argued that upholding the expansive discovery and injunction orders at issue in NML would be harmful to U.S. relations with other foreign states.[34] Justice Scalia’s opinion dismissed such concerns, suggesting that “[t]hese apprehensions are better directed to that branch of government with authority to amend the [FSIA].”[35]NML Capital thus stands in contrast to other recent Supreme Court decisions that have invoked considerations of foreign relations and international comity to limit the reach of U.S. statutes[36] or the power of U.S. courts to adjudicate disputes.[37]

Conclusion

The U.S. Supreme Court’s recent decisions in the NML litigation amount to an unmitigated victory for NML. By holding that the FSIA poses no bar to the Discovery Order, the Court enables the lower federal courts to function as “clearinghouses of information” from around the world for claimants seeking to enforce judgments against foreign sovereign defendants. At the same time, by denying certiorari with respect to the Injunction Orders, the Court let stand a decision whose broad reach and in terrorem effect on third parties increased the pressure on Argentina to honor its debt to NML, but also increased the likelihood that Argentina would instead default on its restructured debt. Each of the Court’s decisions effectively expands the extraterritorial reach of mechanisms invoked by creditors in U.S. courts to enforce foreign sovereign debt obligations.

About the Author: Karen Halverson Cross is an ASIL member and teaches at the John Marshall Law School in Chicago. Her article, The Extraterritorial Reach of Sovereign Debt Enforcement, is forthcoming in volume 12.1 Berkeley Business Law Journal (2014).

[11] Brief for the United States As Amicus Curiae in Support of Petitioner at 30 n.14, NML Capital, 134 S. Ct. 2250 [hereinafter U.S. Amicus Brief (Supreme Court)]; Transcript of Oral Argument of Edwin S. Kneedler on behalf of United States at 26, NML Capital, 134 S. Ct. 2250.

[28] G.A. Res. 68/304, U.N. Doc. A/RES/68/304 (Sept. 9, 2014). The preamble to the Resolution recognizes that a state’s efforts to restructure its debt should not be frustrated by speculative purchases of sovereign debt by distressed debt funds “in order to pursue full payment via litigation.” Id.

[31] A collective action clause allows a debt agreement to be amended upon the vote of a supermajority of creditors and limits the ability of holdout creditors to disrupt a debt restructuring through litigation.

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